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  • BC Network
    Thursday, November 9, 2017

    Last week the House unveiled its tax overhaul plan, the Tax Cuts and Jobs Act (“Act”).  The Act’s proposals related to employee benefits and compensation are as follows:

    Nonqualified Deferred Compensation

    Perhaps one of the most talked about aspects of the Act (at least among benefits practitioners) is the demise of Code section 409A and the creation of its replacement, Code section 409B.

    Under the proposed Code section 409B regime, nonqualified deferred compensation would be defined broadly to include any compensation that could be paid later than the March 15 following the taxable year in which the compensation is no longer subject to a substantial risk of forfeiture, but with specific carve-outs for qualified retirement plans and bona fide vacation, leave, disability, or death benefit plans.  Stock options, stock appreciation rights, restricted stock units, and other phantom equity are included expressly in the definition of nonqualified deferred compensation.

    All nonqualified deferred compensation earned for services performed after 2017 would become taxable once the substantial risk of forfeiture no longer exists, even if payment of the compensation occurs in a later tax year.  As a result:

    • Stock options and stock appreciation rights would become includible in income in the year in which the award vests, without regard to whether they have been exercised.
    • An employee’s deferral of any salary under a nonqualified deferred compensation arrangement until separation from service or otherwise would result in the inclusion of such amount in the employee’s income in the year earned.
    • All salary continuation payments under a severance arrangement would be taxable in the year in which the termination of employment occurs.

    Further, a substantial risk of forfeiture exists only so long as the compensation remains subject to the service provider’s continued substantial future services.  The satisfaction of performance conditions would no longer qualify as a substantial risk of forfeiture.

    All nonqualified deferred compensation earned for services performed before 2018, to the extent not previously includible in income, will be included in income in the last tax year beginning before 2026 or, if later, the date the substantial risk of forfeiture with respect to such compensation no longer exists.  A limited period of time would be provided during which such nonqualified deferred compensation may be amended to conform the date of distribution to the date such amount would be required to be included in the participant’s income without violating Code section 409A.

    Performance-Based Compensation

    The Act also would eliminate the exception to the Code section 162(m) limit on deductible compensation for performance-based compensation, effective January 1, 2018.  The definition of a “covered employee” for purposes of application of Code section 162(m) would change to include an employee who is the principal executive officer or principal financial officer at any time during the taxable year or one of the top three highest-paid employees (or who has ever been a covered employee after 2016).

    Since satisfaction of the specified performance targets would no longer constitute a substantial risk of forfeiture, an employee who participates in a long-term incentive plan that does not require continued employment through the end of the performance period as a condition to receiving the bonus (or the Company subsequently waives such requirement) would be required to include the bonus amount in income in the year in which no additional services are required (even if the final performance results are unknown).

    Beginning in 2018, tax-exempt organizations would become subject to a 20% excise tax on all compensation (cash and the cash value of all remuneration, including benefits paid in a medium other than cash, except for payments to a qualified retirement plan and amounts that are excludable from the employee’s gross income) in excess of $1 million paid to the five highest-paid employees.

    Retirement Plans

    Many of the proposed changes for qualified plans would be favorable for participants.

    Hardship distributions would no longer require participants to cease making contributions during the six-month period after the distribution.  In addition, a defined contribution plan could permit participants to receive a distribution from qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), profit sharing contributions and earnings on any such contributions.  In addition, participants would no longer be required to seek any available plan loan first to alleviate their financial need.

    The minimum age at which a defined benefit pension plan could permit commencement of in-service benefits or a state and local government defined contribution plan could permit an in-service distribution is reduced from age 62 to age 59 ½.

    A participant would have until the due date for filing his or her tax return to roll over a loan balance from a qualified plan to an individual retirement account (IRA), instead of the current 60 day period, before such amount is treated as a distribution.

    Miscellaneous and Fringe Benefits

    Effective January 1, 2018, the following benefits would become taxable to the employee:

    • Reimbursed dependent care expenses under a dependent care assistance program (DCAP) and employer-provided onsite daycare
    • Qualified tuition reimbursement plan benefits
    • Adoption assistance plan benefits
    • Qualified moving-expense reimbursements
    • Employee achievement awards given in recognition of length of service or safety achievement
    • Employer contributions to an Archer Medical Savings Account (accounts could not be established after 2005). Such contributions also would be non-deductible by the employer.

    Transportation fringe benefits would continue to be excludible from employees’ income, but an employer would no longer be entitled to a deduction.

    As expected, the House is engaged in intense negotiations on various parts of the Act so the extent to which any of these provisions will remain in their current iteration in the final version is yet to been determined.

    For more information on the Act’s proposals related to estate transfer taxes, read the Trust Bryan Cave blog’s summary of the Act.

    Tuesday, September 19, 2017

    Securities and executive benefits attorneys and public companies that maintain equity incentive plans should be aware of a new theory of recovery under the “short-swing profit rule.” Plaintiffs’ attorneys have recently asserted a new form of claim alleging liability under the short-swing profit rule when shares are withheld to satisfy applicable taxes upon the vesting of awards.

    Overview of the Short-Swing Profit Rule

    The short-swing profit rule generally provides for strict liability of Section 16 insiders (i.e. an executive officer, director or 10% or more shareholder) if they engage in purchases and sales, or sales and purchases, of issuer equity securities within a six-month period that are not exempt under Section 16. Pursuant to Section 16 of the Exchange Act, a suit to recover short-swing profits may be instituted by the issuer or a shareholder in the name and on behalf of the issuer if the issuer fails or refuses to bring suit within 60 days after request. In practice, a plaintiff’s attorney will frequently make a demand on an issuer to seek recovery of short-swing profits after the attorney identifies non-exempt insider purchases and sales of issuer equity securities within a six-month period and, if the issuer does not resolve the issue to the attorney’s satisfaction, the attorney may then bring suit against the insider.  The potential liability to a Section 16 insider is the disgorgement of any profits earned between the purchase and the sale of the subject securities.  While there is no direct liability on the issuer under the short-swing profit rule, plaintiffs’ attorneys frequently seek a fee from the issuer for identifying the transaction creating Section 16 liability.

    New Plaintiffs’ Claims when Shares are withheld to pay Taxes

    The withholding of shares to satisfy the applicable taxes upon vesting of an award under an equity incentive plan is considered a disposition of shares to an issuer and has traditionally been considered exempt from the short-swing profit rule under Exchange Act Rule 16b-3(e) if the plan or award agreement permits such withholding and such plan or agreement has been approved in advance of the transaction by the issuer’s board of directors, a committee of two or more “non-employee directors” (as defined in Rule 16b-3), or an issuer’s shareholders. However, in several recent cases, plaintiffs’ attorneys have claimed that insider or issuer discretion to elect to have shares withheld at the time of vesting of awards (as opposed to the automatic withholding of shares upon vesting of the award) is not exempt under Rule 16b-3(e), and as a result, the executive is subject to liability under the short-swing profit rule.  In one such case, the court summarily rejected the plaintiff’s claims.  Other cases remain pending.  Commentators have suggested that plaintiffs’ new theories are very weak.

    Considerations in response to Plaintiffs’ Claims

    Notwithstanding the lack of success of these new theories to date, issuers should consider taking steps to minimize the risk of these types of claims either by providing for automatic withholding of shares to satisfy applicable taxes in equity plans and award agreements (which issuers may find undesirable or impracticable), or alternatively, having their board of directors or a committee of non-employee directors approve each withholding transaction in advance (which many issuers will also find impractical).  Also, issuers may want to confirm that their forms of award agreements clearly provide for withholding of shares, and that the board or committee clearly approve the use of such forms when making equity grant awards, to ensure that Section 16 prior approval requirements are met.  In any event, issuers may wish to warn their insiders of potential claims resulting from engaging in a withholding transaction and a non-exempt purchase of securities within any six-month period.

    If you or your organization would like more information, please contact your trusted Bryan Cave LLP lawyer or one of Bryan Cave LLP’s corporate finance or executive compensation lawyers.

    The employee benefits and executive compensation team would like to thank Andrew Rodman and Rocio A. Chavez for preparing this blog post.

    Tuesday, February 21, 2017

    On January 20, 2017, President Trump signed an executive order entitled “Regulatory Freeze Pending Review” (the “Freeze Memo“).  The Freeze Memo was anticipated, and mirrors similar memos issued by Presidents Barack Obama and George W. Bush during their first few days in office.  In light of the Freeze Memo, we have reviewed some of our recent posts discussing new regulations to determine the extent to which the Freeze Memo might affect such regulations.

    TimeoutThe Regulatory Freeze

    The two-page Freeze Memo requires that:

    1. Agencies not send for publication in the Federal Regulation any regulations that had not yet been so sent as of January 20, 2017, pending review by a department or agency head appointed by the President.
    2. Regulations that have been sent for publication in the Federal Register but not yet published be withdrawn, pending review by a department or agency head appointed by the President.
    3. Regulations that have been published but have not reached their effective date are to be delayed for 60 days from the date of the Freeze Memo (until March 21, 2017), pending review by a department or agency head appointed by the President. Agencies are further encouraged to consider postponing the effective date beyond the minimum 60 days.

    Putting a Pin in It: Impacted Regulations

    We have previously discussed a number of proposed IRS regulations which have not yet been finalized.  These include the proposed regulations to allow the use of forfeitures to fund QNECs, regulations regarding deferred compensation plans under Code Section 457, and regulations regarding deferred compensation arrangements under Code Section 409A (covered in five separate posts, one, two, three, four and five).

    Since these regulations were only proposed as of January 20, 2017, the Freeze Memo requires that no further action be taken on them until they are reviewed by a department or agency head appointed by the President.  This review could conceivably result in a determination that one or more of the proposed regulations are inconsistent with the new administration’s objectives, which might lead Treasury to either withdraw, reissue, or simply take no further action with respect to such proposed regulations.

    A Freeze on Reliance?

    The proposed regulations cited above generally provide that taxpayers may rely on them for periods prior to any proposed applicability date.  Continued reliance should be permissible until and unless Treasury takes action to withdraw or modify the proposed regulations.

    The DOL Fiduciary Rule

    The Freeze Memo does not impact the DOL’s fiduciary rule, which was the subject of its own presidential memorandum, discussed in detail elsewhere on our blog.

    Friday, December 9, 2016

    vote-do-not-useLast month, Institutional Shareholder Services (ISS) published updates to its proxy voting guidelines effective for meetings on or after February 1, 2017.  Key compensation-related changes include the following:

    Non-Employee Director Compensation Programs

    In the case of management proposals seeking shareholder ratification of non-employee director compensation, ISS will review such proposals on a case-by-case basis utilizing the following factors:

    • Amount of director compensation relative to similar companies
    • Existence of problematic pay practices relating to director compensation
    • Director stock ownership guidelines and holding requirements
    • Vesting schedules for equity awards
    • Mix of cash and equity-based compensation
    • Meaningful limits on director compensation
    • Availability of retirement benefits or perquisites
    • Quality of director compensation disclosure

    To the extent the equity plan under which non-employee director grants are awarded is on the ballot, ISS will consider whether it warrants support.  When a plan is determined to be relatively costly, ISS vote recommendations will be case-by-case, looking holistically at all of the factors, rather than requiring that all enumerated factors meet certain minimum criteria.

    Equity Plan Scorecard

    Proposals to approve or amend stock option plans, restricted stock plans and omnibus stock incentive plans for employees and/or employees and directors are evaluated using an equity plan scorecard (EPSC) approach.  For 2017, ISS has made the following changes to the EPSC:

    • Addition of New Dividends Payment Factor. Full points will be earned only if the equity plan explicitly prohibits, with respect to all award types, the payment of dividends prior to the vesting of the underlying award.  However, accrual of dividends for payment upon vesting is acceptable.  If such prohibition is not set forth in the equity plan or is incomplete, no points will be awarded.
    • Modification of Minimum Vesting Factor. The equity plan must specify a minimum vesting period of at least one year for all types of awards in order to earn the full points.  Plan provision permitting the reduction or elimination of the one-year vesting requirement under an individual award agreement will result in no earned points.

    Additional information regarding the updates to the EPSC policy is expected in the ISS Equity Compensation Plans FAQ scheduled to be published later this month.

    Amendments to Cash and Equity Incentive Plans

    The ISS clarified that it will vote for proposals to amend executive cash, stock or cash and stock incentive plans if the proposal (i) is only to address administrative features or (ii) seeks approval for Code section 162(m) purposes only and the committee administering the plan consists entirely of independent outsiders.

    Tuesday, August 2, 2016

    Good NewsOn the TV show Futurama, the aged proprietor of the delivery company Planet Express, Professor Hubert J. Farnsworth, had a habit of entering a room where the other characters were gathered and sharing his trademark line, “Good news, everyone!”  Of course, his news was rarely good.  More often, it was the beginning of some misadventure through which the other characters would inevitably suffer, often to great comedic effect.  So we can forgive you for thinking that we may be standing in his shoes when we tell you that new 409A regulations are good news, but really, hear us (read us?) out.

    The IRS released proposed changes to both the existing final regulations and the proposed income inclusion regulations.  And the news is mostly good.  Additionally, taxpayers can rely on the proposed regulations.

    The changes are legion, so we are breaking up our coverage into a series of blog posts. This last in our series is about the changes to the proposed income inclusion regulations and the other minor changes and clarifications made by the regulations.  See our prior posts, “Firing Squad,” “Taking (and Giving) Stock,” “Don’t Fear the (409A) Reaper,” and “Getting Paid.”

    Preventing Waste, Fraud, and Abuse (Okay, well, mostly just abuse). The only change to the proposed income inclusion regulations was to “fix” the anti-abuse rule that applied to correcting unvested amounts that violated 409A.  “Why?” you might ask.  Apparently, because people were abusing it.

    Under the proposed income inclusion regulations, a broken (that’s a technical legal term) 409A arrangement could be fixed in any year before the year it would vest (what we will call “nonvested” amounts). The prior proposed regulations did not put many parameters on how the fix had to happen (other than it needed to, you know, comply with 409A).

    Some hucksters (again, technical term) were apparently amending arrangements that complied with 409A to make them noncompliant. Then they would amend them again to “fix” them in the way they wanted.  This would allow them to get around the change in election rules, as long as the amount would not vest that year.  Clever, perhaps, but pretty clearly not within the spirit of the rules.

    To prevent this kind of abuse, the IRS has revised this permitted correction rule. First, if there is no good faith basis for saying that the arrangement violates 409A, it cannot be fixed.

    Second, the regulations provide a list of facts and circumstances for determining if a company has a pattern or practice of permitting impermissible changes. If they do, then they would not be able to fix a nonvested amount.  The facts and circumstances include:

    • Whether the service recipient has taken commercially reasonable measures to identify and correct substantially similar failures upon discovery;
    • Whether substantially similar failures have occurred with respect to nonvested deferred amounts to a greater extent than with vested amounts;
    • Whether substantially similar failures occur more frequently with respect to newly adopted plans; and
    • Whether substantially similar failures appear intentional, are numerous, or repeat common past failures that have since been corrected.

    Finally, the regulations require that a broken amount be fixed using a method provided in IRS correction guidance. This doesn’t mean that you have to use the correction guidance for unvested amounts.  What it means is that, if a method is available and would apply if the amount was vested, then you have to use the mechanics of that correction (minus the tax reporting or paying any of the penalties).  For example, under IRS Notice 2010-6, if a plan has two impermissible alternative times of payment for a payment event, it has to be corrected by providing for payment at the later of the two times.  You would have to fix a nonvested amount in the same manner under these rules.

    While these changes are intended to ferret out abusers of the rules, this does make it harder for well-intentioned companies who merely have failures to make changes.

    Other Minor Changes and Clarifications.  The proposed regulations also confirmed and clarified the following points of the current final regulations:

    – 409A does apply to non-qualified arrangements of foreign entities that are also subject to 457A.

    – Entities can be subject to 409A as service providers in the same way that individuals are.

    – Payments can be accelerated for compliance with bona fide foreign ethics laws or conflicts of interest laws.

    – On plan termination and liquidation outside a change in control, all plans of the same type (e.g., all account balance plans) have to be terminated. And no additional plans of that type can be adopted for three years.  This is what the IRS always understood the rule to be, but they just made it clearer in these proposed regulations.

    – Payments can also be accelerated, without limit, to comply with Federal debt collection laws.

    Wednesday, July 27, 2016

    Good NewsOn the TV show Futurama, the aged proprietor of the delivery company Planet Express, Professor Hubert J. Farnsworth, had a habit of entering a room where the other characters were gathered and sharing his trademark line, “Good news, everyone!”  Of course, his news was rarely good.  More often, it was the beginning of some misadventure through which the other characters would inevitably suffer, often to great comedic effect.  So we can forgive you for thinking that we may be standing in his shoes when we tell you that new 409A regulations are good news, but really, hear us (read us?) out.

    The IRS released proposed changes to both the existing final regulations and the proposed income inclusion regulations.  And the news is mostly good.  Additionally, taxpayers can rely on the proposed regulations.

    The changes are legion, so we are breaking up our coverage into a series of blog posts. This fourth in our series is about payment-related changes.  See our first three posts, “Firing Squad,” “Taking (and Giving) Stock,” and “Don’t Fear the (409A) Reaper.” Check back for one more post on these regulations.

    What’s a Payment?  That’s not merely a philosophical question.  The current regulations use “payment” a great many times, but without definition.  The proposed regulations state that a payment, for 409A purposes, is generally made when a taxable benefit is actually or constructively received.  For this purpose, if something is included in income under 457(f), it is now treated as a payment for all purposes under 409A.  Additionally, a transfer of nonvested property is not a payment, unless the recipient makes an election to include the current value in income under Section 83(b).

    Additional Permitted Delays for Short-Term Deferral Payments.  Amounts paid shortly after the service provider obtains the right to the payment or becomes vested are exempt from 409A as “short-term deferrals.”  The deadline is the 15th day of the third month following the year in which the right arises or the service provider becomes vested (often, March 15).  If an amount is paid after that date, it is subject to 409A and must comply with 409A’s rules to avoid adverse tax consequences.

    The regulations provided a few limited exceptions where payment could be delayed and still have the payment qualify as a short-term deferral. Now there are two more!  Under the proposed rules, if payment by the short-term deferral deadline would violate Federal securities laws or other laws, then the payment can be delayed until such violation would not occur.  Unfortunately, this exception does not appear to extend to insider trading policies of the company, but in our experience, that is not often a hurdle for the settlement of equity awards that were previously granted.

    Teachers, Professors, et al. Get a Break. Often times, educators and related professions have the choice of being paid over the school year or electing instead to have their 9- or 10-month salary spread out over 12 months.  Since these elections can result in a deferral of compensation, they are potentially subject to 409A (as an aside, it’s hard to see how this is in any way related to the perceived executive compensation abuses that 409A was ostensibly designed to address, but we digress).  The existing rules treated these elections as exempt and thus outside 409A, but only if a small amount of compensation was to be shifted to the next tax year based on this election.  The new proposed rules provide some additional flexibility.

    Under the new proposed rules, these elections are still exempt as long as two conditions are met. First, the compensation cannot be deferred beyond the 13th month following the first day of the service period (e.g., the beginning of the school year).  Second, the service provider’s total compensation for the year cannot exceed the 401(a)(17) limit ($265,000, adjusted annually).

    Wednesday, July 20, 2016

    Good NewsOn the TV show Futurama, the aged proprietor of the delivery company Planet Express, Professor Hubert J. Farnsworth, had a habit of entering a room where the other characters were gathered and sharing his trademark line, “Good news, everyone!”  Of course, his news was rarely good.  More often, it was the beginning of some misadventure through which the other characters would inevitably suffer, often to great comedic effect.  So we can forgive you for thinking that we may be standing in his shoes when we tell you that new 409A regulations are good news, but really, hear us (read us?) out.

    The IRS released proposed changes to both the existing final regulations and the proposed income inclusion regulations.  And the news is mostly good.  Additionally, taxpayers can rely on the proposed regulations.

    The changes are legion, so we are breaking up our coverage into a series of blog posts. This third post is about the death benefit changes.  See our first two posts, “Firing Squad” and “Taking (and Giving) Stock.” Check back for future posts on these regulations.

    Accelerated Payments for Beneficiaries. 409A generally allows plans to add death, disability, or unforeseeable emergency as potentially earlier alternative payment dates.  However, this special rule only applied to the service provider.  If the service provider dies, then the payment schedule applicable on the service provider’s death controlled and generally could not be changed.

    The proposed rules loosen this. Now, plans can add accelerated payments on the death, disability, or unforeseeable emergency of a beneficiary.  This only applies to amounts that are being paid after the service provider’s death, but it creates some welcome flexibility.

    Also, Possibly Delayed Payments for Beneficiaries. The proposed regulations say that a payment on a service provider’s death will be timely if it is made any time between the date of death and December 31 of the year after the death occurs.  Additionally, a plan is not required to have a specific payment window following death to use this rule and it can allow the beneficiary to choose to be paid any time in this window.  If a plan does have a payment period that falls in this window, payment can even be made sooner without amending the plan.

    This is helpful for many reasons. Sometimes companies may not know a service provider has died until months after the death and, even once the company is made aware, it can take time to set up an estate.  This additional payment flexibility is welcome.  (However, we were surprised, with all this talk of death benefits, that the IRS did not incorporate Notice 2007-90.  It’s almost as if they didn’t write it or something.)

    Wednesday, July 13, 2016

    Good NewsOn the TV show Futurama, the aged proprietor of the delivery company Planet Express, Professor Hubert J. Farnsworth, had a habit of entering a room where the other characters were gathered and sharing his trademark line, “Good news, everyone!”  Of course, his news was rarely good.  More often, it was the beginning of some misadventure through which the other characters would inevitably suffer, often to great comedic effect.  So we can forgive you for thinking that we may be standing in his shoes when we tell you that new 409A regulations are good news, but really, hear us (read us?) out.

    The IRS released proposed changes to both the existing final regulations and the proposed income inclusion regulations.  And the news is mostly good.  Additionally, taxpayers can rely on the proposed regulations.

    The changes are legion, so we are breaking up our coverage into a series of blog posts. This second post relates to changes in stock awards and stock sales.  See our first post, “Firing Squad.”  Check back for future posts on these regulations.

    Discounted Stock Buybacks Are Now Okay, Sort of. The existing regulations had a trap for the unwary.  If the stock subject to an option or stock appreciation right (SAR) was subject to a buyback at other than fair market value, then the option or SAR may not be exempt from 409A.  This makes sense when the price is more than fair market value since that could be disguised deferred compensation.  However, often times, companies will have shareholder agreements with discounted buybacks on termination for cause or if an employee violates a non-compete or similar covenant.  Unless an exception applied, this would mean that the option or SAR would have to comply with 409A’s timing rules, which are often contrary to what both the company and the recipient desire.

    Under the new proposed rules, mandatory buybacks at less than fair market value are okay as long as they only apply if either (A) the recipient is terminated for cause or (B) the occurrence of a condition within the recipient’s control (such as the violation of a non-compete).  Though these buybacks are also permitted under existing rules as long as they are so-called “lapse restrictions” (which means they have a limited duration), the additional flexibility provided by the proposed regulations is welcome in this area.

    Awards Prior to Date of Hire can Still Be Exempt. Under the existing rules, an option or SAR had to be for stock of the company for which the individual was working (or certain affiliated entities) for it to be exempt from 409A.  But what if you wanted to grant an option to someone prior to date of hire?  That option would technically need to comply with 409A and its onerous timing requirements.

    The proposed rules add additional flexibility in this regard. You can grant an option or SAR and have it be exempt as long as the service provider is expected to start work within 12 months (and actually does so).  If the service provider doesn’t start work within that 12 month period, then the award has to be forfeited (but honestly, you probably wanted it that way anyway).

    Change in Control Rule Applies to Exempt Stock Rights. Sometimes in a transaction, employees with stock awards are given rights to get paid on the same terms as shareholders.  For awards subject to 409A, the rules generally permit this as long as the payments do not go beyond five years from the date of the change in control.  However, since options and SARs with fair market value strike prices are exempt from 409A, there was some question as to whether this rule could be used with those awards.  These proposed regulations confirm that it can.

    A Stock Sale Means a Stock Sale. Generally, if a company’s stock is sold, the employees are not treated as having terminated employment/separated from service for 409A purposes.  On the other hand, in an asset sale, the buyer and seller can agree whether the sale constitutes a separation from service/termination of employment for 409A purposes.

    But under Section 338 of the Code, parties can elect to treat a stock sale as a deemed asset sale for tax purposes. Does this include 409A, which would then allow them to choose whether a separation from service has occurred?  The proposed regulations say it does not.  Therefore, employees will not have a separation from service, even if a 338 election is made.

    Thursday, July 9, 2015

    Guy GrabbingLast week the Securities and Exchange Commission (SEC) proposed a new Rule 10D-1 that would direct national securities exchanges and associations to establish listing standards requiring companies to adopt, enforce and disclose policies to clawback excess incentive-based compensation from executive officers.

    • Covered Securities Issuers. With limited exceptions for issuers of certain securities and unit investment trusts (UITs), the Proposed Rule 10D-1 would apply to all listed companies, including emerging growth companies, smaller reporting companies, foreign private issuers and controlled companies. Registered management investment companies would be subject to the requirements of the Proposed Rule only to the extent they had awarded incentive-based compensation to executive officers in any of the last three fiscal years.
    • Covered Officers.   The Proposed Rule would apply to current and former Section 16 officers, which includes a company’s president, principal financial officer, principal accounting officer (or if none, the controller), any vice-president in charge of a principal business unit, division or function, and any other officer or person who performs policy-making functions for the company. Executive officers of a company’s parent or subsidiary would be covered officers to the extent they perform policy making functions for the company.
    • Triggering Event. Under the Proposed Rule, the clawback policies would be triggered each time the company is required to prepare a restatement to correct one or more errors that are material to previously issued financial statements and would be applied to covered officers even in the absence of any misconduct. Changes to a company’s financial statements that arise for reasons other than to correct an error (g., change in accounting principles, revision for stock splits and adjustments to provisional amounts related to a prior business combination) would not trigger any required recovery action.
    • Three-Year Lookback. A company would be required to recover excess incentive-based compensation received by covered officers within the three completed fiscal years prior to the date the company is required to prepare the accounting restatement. Under the Proposed Rule 10D-1, an accounting restatement would be treated as required on the earlier of: (1) the date the company concludes or reasonably should have concluded that its previously issued financial statements contain a material error; or (2) the date a court, regulator or other authorized body directs the company to restate a previously issued financial statement to correct a material error. For example, if a company that operates on a calendar year determines in November 2018 that a previously issued financial statement contains a material error and files the restated financial statements in January 2019, the recovery policy would apply to all excess incentive-based compensation received by covered officers in 2015, 2016 and 2017.
    • Incentive-Based Compensation. Under the Proposed Rule, incentive-based compensation is any compensation that is granted, earned or becomes vested (in whole or in part) due to the achievement of any financial reporting measure (g., revenue, operating income and EBITDA) or performance measures based on stock price and total shareholder return. Incentive-based compensation generally would not include salary, discretionary bonus payments, time-based equity awards, non-equity awards based on achievement of a strategic measure (e.g., consummation of a merger) or operational measures (e.g., completion of a project) or bonus pool awards where the size of the pool is not based on satisfaction of a financial reporting measure performance goal. However, if a covered officer earns a salary increase based (in whole or in part) on the attainment of a financial reporting measure, the increase could be considered a non-equity incentive plan award and subject to recovery under the Proposed Rule 10D-1.

    For purposes of applying the three-year lookback period, incentive-based compensation would be deemed received in the fiscal period during which the financial reporting measure specified in the incentive-based compensation award is attained, even if the payment or grant occurs after the end of that period. Consequently, the date of receipt would depend upon the terms of the award. For example, if an award is granted based on satisfaction of a financial reporting measure, the award would be deemed received in the fiscal period when that measure was satisfied. However, if an equity award vests upon satisfaction of a financial reporting measure, the award would be deemed received in the fiscal period when it vests. Any ministerial acts or other conditions necessary to effect issuance or payment (e.g., calculating earned amounts or obtaining board of approval) would not be determinative of the date the incentive-based compensation is received by the covered officer.

    • Determining Recoverable Amount.    The amount subject to recovery would be the amount of incentive-based compensation received by a covered officer that exceeds the amount the officer would have received had the incentive-based compensation been determined based on the accounting restatement. Although the Proposed Rule does not specify a means of recovery, it does offer guidelines for determining the recoverable amount under different types of incentive-based compensation arrangements.
      •  Cash Bonus Pool Awards. The company would reduce the size of the aggregate bonus pool based on the restated financial reporting measure and if the reduced bonus pool is less than the aggregate amount of individual bonuses received from it, the excess amount of an individual bonus would be the pro rata portion of the deficiency. If the aggregate reduced bonus pool would have been sufficient to cover the individual bonuses received from it, then no recovery would be required.
      • Equity Awards. The method of recovering equity awards would depend on the status of the award. With respect to shares, options or SARs still held by the covered officer at the time of recovery, the recoverable amount would be the number received in excess of the number that should have been received applying the restated financial reporting measure.   If the options or SARs have been exercised but the covered officer still holds the underlying shares, the recoverable amount would be the number of shares underlying the excess options or SARs applying the restated financial measure. However, if the shares have been sold, the recoverable amount would be the sale proceeds received by the covered officer on the excess number of shares. In all situations, the covered officer’s payment of any applicable exercise price would be taken into account.
      • Nonqualified Deferred Compensation. The covered officer’s account balance or distributions would be reduced by the excess incentive-based compensation contributed to the nonqualified deferred compensation plan and any interest or earnings accrued thereon. In addition, for retirement benefits under pension plans, the excess incentive-based compensation would be deducted from the benefit formula, and any related distributions would be recoverable.
    • Exceptions to Recovery. Proposed Rule 10D-1 provides for two limited exceptions to recovery.
      • Impracticable Recovery. Recovery would not be required if determined by the company’s committee of independent directors (or in the absence of such a committee by a majority of the independent board members) to be impracticable because the direct costs of recovery would exceed the amount subject to recovery. However, before concluding that recovery would be impracticable, the company must make a reasonable attempt at recovery and furnish the exchange with documentation of its efforts. This and all other determinations made by a company under Proposed Rule would be subject to review by the listing exchange.
      • Violation of Home Country Law. Recovery also would not be required if it would violate the company’s home country law; however, the company would be required to obtain an opinion of home country counsel (acceptable to the applicable national securities exchange or association) that recovery would result in such a violation. In an effort to deter countries from changing their laws in response to this exception, the Proposed Rule would limit application of this exception only to laws adopted prior to the date of publication of the Proposed Rule in the Federal Register.

    Under either exception, a company would be required to disclose why it decided not to pursue recovery of the excess incentive-based compensation.

    • Prohibited Indemnification or Reimbursement. A company would be prohibited from mitigating or otherwise entering into an arrangement designed to avoid or nullify the effect of any required recovery, including indemnifying a covered officer against the loss of excess incentive-based compensation or paying or reimbursing the officer for the purchase of an individual third-party insurance policy to fund potential recovery obligations.
    • Disclosure Obligations. The recovery policies would be a required exhibit to the company’s annual report on Form 10-K. Additional disclosures would be required in the company’s annual report and any proxy and consent solicitation materials requiring executive compensation disclosure if at any time during its last completed fiscal year the company either prepared an accounting restatement that required recovery action or had an outstanding balance of excess incentive-based compensation. The SEC also proposes requiring a company to make the appropriate amendment to the Summary Compensation Table for the fiscal year in which the amount recovered was initially reported and be identified by footnote.
    • What’s Next. The Proposed Rule is subject to a 60-day comment period following its publication in the Federal Register. The SEC is soliciting comments on virtually every aspect of the Proposed Rule so the final version of the rule could possibly reflect significant changes. Exchanges will have 90 days after the adopted version of Rule 10D-1 is published in the Federal Register to file its proposed listing rules, which must be effective no later than one year following that publication date.

    Listed companies must adopt recovery policies within 60 days after the exchanges’ rules become effective and begin enforcing such policies on all incentive-based compensation received by covered officers (current and former) as a result of satisfaction of a financial reporting measure based on financial information for any fiscal period ending on or after the effective date of Rule 10D-1.   Failure to adopt and enforce the required recovery policies would subject a company to delisting.

     

    See also this client alert Securities group posted on bryancave.com.

    Thursday, April 9, 2015

    ChartCompanies should be aware that at least some major accounting firms are questioning whether discretionary aspects of clawback policies trigger variable accounting for compensatory equity awards granted by those companies. Existing accounting guidance (ASC 718-10-30-24) would seem to suggest that clawback features should not disrupt fixed accounting treatment because of their contingent nature.

    Now, however, PricewaterhouseCoopers and KPGM, at least, are publicly expressing concerns about clawback policies focusing on their discretionary, rather than contingent, nature. A 2013 PricewaterhouseCoopers survey of 100 companies indicated that nearly 80% of those companies had clawback policies that had problematic discretionary provisions. A clawback policy could involve discretion as to what circumstances it may apply; whether it should be applied; and, if applied, how severely it should be applied. It seems that all aspects of discretion may be problematic. Companies adopting or modifying existing clawback policies should evaluate the potential risks of discretionary provisions and consider consulting with their independent accountants before adopting or revising those policies. This will be particularly true for public companies when it comes time to evaluate compliance with the much-anticipated SEC guidance on clawbacks that will finally implement the Dodd-Frank legislation of 2010.